Analysis of the relationship between Internal rate of return and net present value

In the process of investment decision, it is very important to evaluate the profitability of the project. Internal rate of return (IRR) and net present value (NPV) are two commonly used investment evaluation indicators, which are closely related and influence each other. This paper will make an in-depth analysis of the relationship between the two indicators to help investors better understand their functions and applications.

Concept and calculation method of Internal rate of return (IRR)

Internal rate of return (IRR) refers to the discount rate that makes the net present value (NPV) of the project equal to zero, that is, under this discount rate, the cash inflow of the project is equal to the present value of the cash outflow. To calculate IRR, you need to use iteration or interpolation, by constantly trying different discount rates until you find the value that makes NPV zero.

The concept and calculation method of net present value (NPV)

Net present value (NPV) refers to the difference between the future cash inflow and cash outflow of the project, which is converted to the present value according to a certain discount rate. To calculate NPV, you need to convert the expected cash flow of the project according to the predetermined discount rate, and then sum it.

The relationship between Internal rate of return and net present value

The relationship between internal rate of return and net present value can be understood from the following aspects:

oneRoulettemaster. Mutual calculation premise: when calculating IRR, we need to set NPV to zero, so as to calculate the corresponding discount rate; while in calculating NPV, we need to choose an appropriate discount rate, and IRR is an important reference of this discount rate.

two。 Investment decision-making basis: IRR and NPV are important indicators to evaluate the profitability of the project. Generally speaking, if the IRR is greater than the minimum rate of return required by investors, and the NPV is positive, then the project has investment value.

3. Sensitivity analysis: in the project investment analysis, we can use the sensitivity analysis of IRR and NPV to understand the impact of different discount rates on project profitability. By adjusting the discount rate, we can observe the stability and risk of the profitability of the project in different scenarios.

Case analysis

In order to better understand the relationship between internal rate of return and net present valueRoulettemasterWe analyze it with a specific case. Assuming that an investment project requires an initial investment of 1 million yuan, the cash inflows in the next five years are expected to be 300000 yuan, 400000 yuan, 500000 yuan, 600000 yuan and 700000 yuan respectively.

Discount rate table

Discount rate net present value (NPV) 5% 853300 yuan 10% 524700 yuan 15% 110700 yuan 20-287400 yuan

Through the calculation, we find that the net present value (NPV) of the project is 853300 yuan at the discount rate of 5% and 524700 yuan at the discount rate of 10%. After iterative calculation, we get that the internal rate of return (IRR) of the project is about 14.35%. Based on these data, we can draw the following conclusions:

1. When the minimum rate of return required by investors is 5%, the net present value (NPV) of the project is 853300 yuan, which is higher than 0, and the IRR (14.35%) is greater than the required rate of return, so the project has investment value.

two。 When the minimum rate of return required by investors is 10%, the net present value (NPV) of the project is 524700 yuan, which still has investment value. However, at a 20 per cent discount rate, NPV is negative and the investment value of the project is questionable.

Through the above analysis, we can draw the conclusion of the relationship and interaction between the internal rate of return and the net present value. In the actual investment decision, investors should comprehensively use these two indicators, combined with their own risk tolerance and project characteristics, to make a wise investment choice.